Is US Economic Momentum Really That Strong?
June 24, 2024
Last week Statistics Canada confirmed that our Consumer Price Index (CPI) increased by 2.9% in May on a year-over-year basis, up from 2.7% in April. For the first time this year, the CPI print came in higher than the consensus forecast (which was 2.6%).
Bond-market investors responded by pushing up the Government of Canada (GoC) bond yields, which our fixed mortgage rates are priced on, and by lowering the odds of a Bank of Canada (BoC) rate cut at its next meeting on July 24 to about 50%.
Those initial reactions were as expected, and I don’t think they will have a lasting impact on our mortgage rates or on the BoC’s rate-cut timing.
At the press conference following the BoC’s most recent policy-rate decision in June, Governor Macklem predicted that “further progress in bringing down inflation is likely to be uneven”. So the latest CPI result wasn’t a surprise, and despite last month’s uptick, our CPI is still below the level the BoC forecast in its April Monetary Policy Report (as per CIBC Chief Economist Avery Shenfeld).
The Bank’s current policy rate (4.75%) is still highly restrictive.
The next rate cut will make conditions less tight, but it won’t make them loose. The BoC will just be easing off a little on the tourniquet. We will still be well above its estimated neutral-rate range of 2.5% to 3% (which is the notional level where the policy rate is neither restricting growth nor stimulating it).
The need for a drum-tight policy rate has diminished quickly.
Overall GDP growth has virtually stalled out, consumer spending has slowed, credit usage and default rates have risen steadily, and business bankruptcies are spiking.
Our economy is also losing momentum from some of the key sources of resilience. Canadian consumers aren’t tapping their savings as much anymore. Many of them have spent most of what they accumulated during the pandemic, and immigration rates have peaked.
The impact from sharply higher mortgage renewal rates is a growing concern.
Only about half of Canadian mortgage borrowers have renewed into higher rates thus far. The borrowers who have yet to renew will experience greater payment shocks because the gaps between their existing rate and their renewal rate will be wider. The BoC estimates that average mortgage payments have risen by about 9% thus far, and it expects that increase to nearly double to 17% by 2027.
Of course, the BoC can help mitigate that impact by continuing to cut its policy rate, and doing so under these conditions will also put downward pressure on our CPI. Mortgage- interest costs still account for a significant portion of our current inflation pressure. They increased by 23.3% in May (annualized) and accounted for about 0.7% of our total 2.9% CPI increase.
Interestingly, Stats Can just announced that it will increase its CPI weighting of mortgage- interest costs from 3.46% to 5.2% going forward (hat tip to Ben Rabidoux for that insight).
That change will increase the inflationary impact of mortgage-rate resets over the near term but will also magnify the disinflationary impact that falling mortgage rates will have farther down the road. 
The Bottom Line: GoC bond yields increased sharply last week in response to our higher-than-expected inflation data. They are now back to the upper end of their recent range. If they continue to move higher over the near term, we may see a round of increases in fixed mortgage rates.
Variable-rate discounts were unchanged last week.
While the bond futures market is less confident that the BoC will cut at its next meeting, I still see that as the most likely outcome. Last week’s disappointing CPI result did produce a strong market reaction, but I don’t think it will alter the BoC’s rate-cut plans.
For the reasons outlined above, I think the Bank will share CIBC Chief Economist Avery Shenfeld’s assessment that “the broad direction of the economy is towards a disinflationary cooling, even if the weathervane pointed the other way this month.”